MARGINAL COST

Meaning of marginal cost-CIMA

defines;
Amount at any given volume of output by which
aggregate costs are changed if volume of output
is increased or decreased by one unit .It relates
to change in output in particular circumstances
under consideration.
 Meaning of marginal costing –A/C
to CIMA,
Marginal costing is the ascertainment of marginal cost
and of the effect on profit of changes in volume or type
of output by differentiating fixed cost &variable cost .In
this technique of costing only variable cost are charged
to operation ,processes or products leaving all indirect
cost to be written off against profits in period in which
they arise.
 Difference Between Absorption
costing & Marginal costing
 All costs fixed &variable are included for
ascertaining the cost.
 Different unit costs are obtained at different levels
of output because of fixed expenses remaining
same.
 Difference between sales &total cost is profit.
 A portion of fixed costs is carried forward to the
next period because closing stock of work -in -
progress & finished goods is valued at cost of
production which is inclusive of fixed cost. In this
way costs of a particular period are vitiated because
fixed cost being period cost should be charged to
the period concerned & should not be carried over
to next period .
 The apportionment of fixed expenses on an
arbitrary basis given rise to over or under
absorption which ultimately makes the product cost
inaccurate and unreliable.
 Absorption costing is not very helpful in taking
managerial decision such as whether to accept the
export order or not ,whether to buy or manufacture
,the minimum price to be charged during
depression etc.
 Costs are classified according to functional basis
such as production cost ,office and administrative
cost and selling and distribution cost.
 Absorption costing fails to establish relationship of
cost volume and profit as costs are seldom
classified into fixed &variable.
 Only variable cost are included .fixed cost are
recovered from contribution.
 Marginal cost per unit will remain same at different
levels of output because variable expenses vary in
the same proportion in which output varies.
 Difference between sales and marginal cost is
contribution and difference between contribution
and fixed cost is profit or loss.
 Stock of work- in-progress and finished goods are
valued at marginal cost which does not include
fixed cost .Fixed cost of a particular period is
charged to that very period and is not carried
forward to next period by including in closing stock
.Being so ,cost of a particular period are not
vitiated.
 Only variable cost are charged to products
.marginal cost technique does not lead to over or
under absorption of fixed overheads.
 The technique of marginal costing is very helpful in
taking managerial decisions because it takes into
consideration the additional cost involved only
assuming fixed expenses remaining constant.
 Cost are classified according to the behaviour of
cost i.e. fixed cost and variable cost.
 Cost ,volume and profit relationship is an integral
part of marginal cost studies as costs are classified
into fixed and variable costs.
 IMPORTANCE;
Fixed expenses are not allocated to cost
units but are charged against ‘fund’ which
arises out of excess of sales price over
total variable costs.
 LIMITATIONS;
 Technical difficulties.
 Time taken for completion of jobs is not given due
attention.
 Less effective.
 Balance sheet will not exhibit true and fair view.
 Problem of apportionment of variable cost still arises.
 Difficulty to apply in contract or ship building industry.
 Does not provide any standard.
 General reduction in selling price and thus losses.
COST–VOLUME –PROFIT ANALYSIS
 Assumptions;

 Fixed cost remain static & marginal costs are

completely variable at all levels of output.
 Selling prices are constant at all sales volume.
 Factor prices are constant at all sales volume .
 Efficiency and productivity remain unchanged. In
a multi product situation ,there is constant sales
mix at all level of sales.
 Turnover level is only relevant factor affecting
cost & revenue.
 Value of production is equal to volume of sales.
 ELEMENTS-
 MARGINAL COST EQUATION
 CONTRIBUTION MARGIN .
 PROFIT /VOLUME RATIO .
 BREAK EVEN POINT .
 MARGIN OF SAFETY.
MARGINAL COST EQUATION
SALES=VARIABLE COSTS +FIXED
EXPENSES+P/L
OR
S-V=F+P/L
CONTRIBUTION MARGIN-
CONTRIBUTION =SELLING PRICE –MARGINAL COST
OR
C=F+P/L
OR
C-F=P/L
 PROFIT /VOLUME RATIO;
P/V=CONTRIBUTION /SALES
OR
F+P/L/V.C+F.C+P/L=[F+P/S]
OR
S-V/S=CHANGE IN PROFITS OR CONTRIBUTION/CHANGE IN
SALES
 BREAK EVEN POINT;
B.E.P=FC/P/V
OR
TOTAL FIXED EXPENSES/S.P PER UNIT-MC PER UNIT
OR
TOTAL FIXED EXPENSES/CONTRIBUTION PER UNIT
VALUE OF SALES TO EARN DESIRED
AMOUNT OF PROFIT ;

SALES=F.C+D.P/P/V RATIO
 MARGIN OF SAFETY ;

 MOS=PROFIT/P/V RATIO
 DIFFERENCE BETWEEN CONTRIBUTION
&PROFIT
 Includes fixed cost &
profit .
 Based on marginal cost
concept.
 Contribution above break
even contributes to profit.
 Contribution analysis
requires a knowledge of
break even concept.
 Does not include fixed
cost.
 Based on common man
concept.
 Profit is expected only
after covering variable
and fixed cost.
 Profit does not require
any such concept.
APPLICATION OF MARGINAL COST & COST,
VOLUME & PROFIT ANALYSIS-
 COST CONTROL.
 PROFIT PLANNING.
 EVALUTION OF PERFORMANCE.
 DECISION MAKING.
 FIXATION OF SELLING PRICE.
 KEY LIMITING FACTOR.
 SUITABLE PRODUCT MIX.